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July 12, 2022

Riding the Outsourced Trading Wave

As the outsourced trading wave builds, Gerard Walsh and Grant Johnsey explore the factors driving managers to consider outsourcing their trading desks and considerations for selecting a model – from partial to full outsourcing.

By Gerard Walsh and Grant Johnsey of Northern Trust Capital Markets

 

As mounting pressures from regulations, evolving technology and market volatility put more stress on investment managers of all sizes, many are considering unbundling their trading desks. Firms that outsource this function may be better able to manage volume spikes, access advanced technology and focus on risk and governance thanks to the expertise, scale and capability of their outsourced trading partners.

For example, in the European Union and the U.K., firms have turned to outsourced trading providers to help them manage the reporting needs of regulations such as MiFID II. These rules, which were implemented in 2018, increase the requirements for reporting, tracking and recording of transactions and proof of execution value. While it’s important to note that the outsourcing process does not outsource clients’ regulatory obligations, choosing an experienced third-party provider may help firms by providing scale and technological capabilities that can contribute to oversight, risk management and compliance.

There are multiple outsourcing models from which a manager can choose, from partial to full outsourcing. Choosing the right expertise, cultural fit, people and customisation around specific needs can help a firm make the best decision for them.

Dipping a Toe into Outsourced Trading

Using a partially outsourced trading model is an easy and adaptable way to dip your toe into the world of outsourced trading. Like a switch that can be turned on and off as needed, these hybrid models help to ensure that the operational infrastructure necessary to support the firm’s strategy is in place, adjusting trade execution to the ebb and flow of a given period. Rather than hiring a trader with expertise in trading certain asset classes or in unfamiliar markets or geographic locations, the investment manager can leverage an outsourced provider with traders who fit that need. Alternatively, a firm may use an outside trading desk during holidays or instances of extremely high market volume when extra hands are needed.

There are multiple reasons firms maintain trading desks. These include the perception that a fully outsourced trading model is primarily used by start-ups and boutique firms, or that not having an in-house trading desk will deter clients. There is the fear of losing control over their trading, or that managers won’t stay as close to the market if they are not sitting next to their traders. The last two years of the pandemic have demonstrated that the latter may be unfounded with traders and portfolio managers frequently working from different locations.

While partial outsourced trading models serve a purpose, a firm may not be receiving the full benefits of outsourced trading.

Reaping the Benefits of Full Outsourcing

What are the main benefits of a fully outsourced trading model? One key advantage is access to crossing opportunities in extensive, unique pools of liquidity  ̶  especially in small- and mid-cap stocks. Liquidity provision is a primary component of the outsourced model, and it is almost always the case that scale providers have deeper pools.

Expert providers not only have knowledge of regulations across the globe but can also enrich the trade process by pairing services with other capabilities, such as foreign exchange and firm-wide transaction cost analysis reporting. Plus, there are fewer worries about staffing as human resources will be handled by the outsourced trading provider.

Another advantage of full outsourcing is the potential to generate cost savings. Trading infrastructure is one of the biggest differences between the full and partial outsourced trading models. Trading desks require extensive infrastructure, personnel and IT investment that carry with them significant capital expenditures. Potential cost savings persuade many asset managers to fully outsource their trading operations. Take a look at the numerous fees and subscriptions required by a trading desk that firms can eliminate from their balance sheet with full outsourcing: data service subscriptions such as Bloomberg, trading fees, SWIFT fees and data licensing in various jurisdictions, to name a few.

Overall, fully outsourcing trading to a provider that seamlessly operates as an extension of the asset manager can create organisational efficiencies. This enables in-house decision makers to focus their attention on what will bring the most value to the firm: finding the best investments to support investors’ goals and building distribution channels. In doing so, asset managers may strengthen their position in relation to competitors, as well as their ability to anticipate and adapt to evolving circumstances.

As the outsourcing wave builds, asset managers that recognise and take advantage of the full spectrum of benefits enabled by handing off their trading functions are working with client interests in mind. 

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